A Run on America

"This recession will be long and deep and when we get out of it, we'll have inflation." Kenneth Rogoff, Harvard University This is clearly a run on America, its financial institutions, and of course the dollar. How bad can things get? The answer is: very bad indeed, but not necessary in the way many people think. Don't make the mistake, as some commentators are doing, to think of this as some kind of straight-line process towards a 1930s style deflation. Just because deflation happened then, does not mean that it happens today. Deflation is not the result of an economic downturn. Deflation, just as inflation, is a monetary phenomenon. Given how expansionary monetary policy has been world wide, deflation is de facto impossible. (By this I do not mean a fall in price over short periods, but an expectation by people that price will continue to fall). Kenneth Rogoff is right about his observation. This is a brutal financial crisis, which is very likely to lead to a long and nasty recession in the US. But the outcome of this crisis is more likely to by hyperinflation, than deflation. People always say: Come on. It won't be as bad as the 1970s. To which I would respond: Why should it be as benign in the 1970s? We have a persistent hike in the price of energy, much worse than in the 1970s, a US central bank with no interests in anchoring inflationary expectations, much worse than in the 1970s, and collapsing asset markets. This time, the Fed not only accepts the risk of higher inflation. It actually appears to seek higher inflation, as this would ease some of the problems (obviously not for all of the people). Inflation reduces the pain of borrowers. A 50% real fall in house prices is so much easier to stomach if annual inflation runs at 8% than at 2%. And by some measures, US annual inflation already runs at that level. This conflagration will mean three things: It will mark the end of the US as the world sole economic superpower; the end of the dollar as the global reserve currency, and its replacement by the euro; and the de facto end of Anglo-Saxon transaction-based financial capitalism. All three are, of course, related, but it is worth pondering those consequences in turn. The US financial superpower status was geared not primarily to the relative size of the US economy, close to 30%, but in terms of the role played by the US in the globalisation Ponzi game. The US current account deficit was an important part of this game, as was China's China c/a surplus and its undervalued currencies. But as the dollar collapses and inflation rise, the US will not be able to maintain that game indefinitely. Nor will it be able to maintain the status as a global reserve currency for any length of time, as rising inflation will not be acceptable for many economies pegged to the dollar. The euro is the currency of the least inflated global economic region, and such offers the best store of value - a consideration likely to prove increasingly important as this crisis unfolds. And as we observe a shift of global capital flows out of the US into the euro area, we will observe the decline of the Anglo-Saxon model of transaction-based financial capitalism almost as a byproduct. So this run on financial America is not only a huge financial events. It is a geostrategic shift of great importance.

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